How Your Credit Score is Calculated

How are credit scores calculated, and what can I do to improve my score before buying a house? This is one of the most common questions I receive from readers. So I'd like to offer a video explanation to help you better understand it. This video shows how your score gets calculated through the FICO scoring model.

Video transcript: Today we're going to talk about the five factors used to calculate your credit score. This is a relevant topic for anyone who is planning to shop for a mortgage, or refinance an existing mortgage loan. Credit scores are very important to a lender's final decision. So if you want to increase your chances of getting approved for a loan, you need to know where your score comes from.

There are five categories of information that influence your credit score. We will talk about all five of these categories during the course of this video. We will also discuss the things you can do to optimize those factors to maintain a higher score.

[Narrator draws a pie chart with five parts.] You can see that there are five slices that make up the pie chart. These are the factors used to calculate your FICO credit score. The FICO scoring model goes from 300 to 850. A higher number is better.

How Your Score is Calculated

You can see from the chart that the five pieces add up to 100% of your score [see video above]. So let's look at these five items in more detail:

1. Your Payment History

We're going to talk about the biggest piece first, which accounts for 35% of your credit score. This is your payment history. This is your history of paying back loans and other debts. It primarily includes your credit cards, car payments, student loans, and similar types of debt.

If you pay these accounts on time, it will boost your credit score. But if you have a pattern of missed payments, late payments or even collection accounts, it will do serious damage to your score. That's because this category weighs most heavily in the overall scoring model.

The Credit Reporting Process
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2. Amounts Owed

Another 30% of your credit score is determined by the amounts owed. This refers to the amount you owe on your various credit accounts, or your "utilization ratio."

I'm going to draw it out for you so it makes more sense. [Narrator draws a vertical bar and colors in the bottom portion.] This bar represents the limit on your credit cards. If you're only using a third of your limit, it will probably help your credit score because you're only using a small amount. If you're using a high percentage of your available limit, it will hurt your score.

Let's say you're using this much of your available limit. [Narrator colors in the entire bar.] Here's a situation where you've maxed out your credit cards. This will hurt your FICO score even more.

So the lower your balance is relative to your credit limit, the better off you are. What can you do to optimize this area? You can pay down your credit card balances. If you do this, you'll probably see an improvement in your score.

3. Length of Credit History

This is another factor used to calculate your credit score, and it accounts for 15% of to total score. This is the length of time you've had some form of credit. It will probably date back to the first loan you obtained, or the first credit card you took out. With all other things being equal, a longer history is better.

You might think there's nothing you can do to improve this area, and that's true in one sense. But you can harm yourself here by closing your oldest credit account.

So if you have a credit card you took out when you were 18 and you're now 30, and all your other accounts are much newer, you should be careful about closing that oldest account. Doing so would shorten the length of your credit history, and that could possibly hurt your credit score. It basically gives the scoring model a shorter "look" to determine how well you've paid back your debts in the past.

If you have a long history of responsible credit usage, you want to keep it that way. So be careful about closing those older accounts.

4. New Credit Accounts

Credit scores are also calculated by using the number of new accounts you've opened. You can chalk up another 10% for this factor. These are new loans and credit cards that you've applied for recently. A bunch of new accounts will have a negative effect on your score.

What you can do here is just limit the amount of credit accounts you take out. Don't take out new loans and credit cards unless they're absolutely necessary. And when you're rate shopping for a mortgage loan, do it within a small period of time. The FICO credit-scoring model is designed to recognize this as normal rate shopping, so it won't necessarily penalize you for multiple inquiries.

But if you have a lot of inquiries because you're taking out store credit cards and loans (and generally over-relying on credit), you will hurt your credit score.

5. Types of Credit

Another 10% (rounding out the full 100%) goes to the types of credit you use. This is kind of a lesser factor in the overall scoring model. But it's still used to calculate your credit score, so it needs to be mentioned.

Having a broader mix of credit accounts (credit cards, student loans, personal loans, car loans, etc.) will help your score more than a single credit account -- with all other things being equal. It just gives the scoring model more information to look at.

The Most Important Factors

So again, the two most important factors used to calculate your credit score are:

  • Payment history
  • The amounts owed on your credit account

These are two things you have a lot of control over, as well. Your payment history shows how you've borrowed and repaid money over time. The amounts that you owe show whether you're a responsible lender, or if you overuse your credit. Obviously, both of these things would be important to a mortgage lender.

These two items alone account for more than 65% of your credit score. So make your payments on time. Reduce your debts, and particularly your credit card balances. Do your rate shopping in a small window, so you don't have a lot of inquiries spread over a long period of time. Limit the amount of credit you use. Don't take out a new account if you don't absolutely need it.

Additional points to remember:

  • Your FICO credit score is calculated based on the information found within your credit reports. So it's a good idea to check your reports once a year, just to make sure they're accurate.
  • Your credit score is calculated by using all five of these categories of information, not just one or two.
  • How much a scoring factor affects you will depend on the overall information in your credit report. For instance, if you have a ten-year history of timely payments with only one missed payment, that one mistake won't do as much damage. But if you have a pattern of missed payments, you'll do more damage to your score.
  • It's hard to say how much a particular factor will influence your score. It depends on your credit history. A missed payment or a bankruptcy filing can affect people's scores in different ways. Or, as the folks at FICO say: "What's important is the mix of information, which varies from person to person, and for any one person over time."
  • Mortgage lenders will look at other factors besides your credit score. They will consider your income, your employment history, the total amount of debt you have, and other factors relating to your finances.

This article explains how credit scores are calculated. If you'd like to learn more about this topic, you can use the search box at the top of this page. You'll also find a lot of related information in our credit library.